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An ETF to Plug Into Alternative Energy

Roger Nusbaum

03/07/06 - 08:40 AM EST

Every time CNBC does a segment on how expensive oil, gasoline and natural gas are, my wife asks why we don't have more solar energy. All of the politics notwithstanding, that's the right question.

Alternative energy seems like it has been the next big thing for years. Perhaps now, with the cost of energy so much higher, more car companies making hybrid vehicles and a greater need for alternative power sources such as wind, this could be a time when money could be made by investing in alternative energy.

PowerShares has a year-old alternative energy ETF, the PowerShares WilderHill Clean Energy Portfolio(PBW Quote). The fund has 41 stocks in it, most of which you probably haven't heard of, but as is the case with most PowerShares funds, no one stock has too large a weighting. Its largest holding, at 4.1% of assets, is the carbon-fiber maker Zoltek (ZOLT Quote).

Industrials, including a number of fuel-cell and solar-panel makers, account for 37% of the fund's assets. Its second-largest concentration is 30% in information technology. It holds a number of semiconductor companies.

Despite the heavy weighting to industrials and semiconductors, the fund has no real correlation to either sector.

It has had a much tighter correlation to the energy sector over the past year, though it has no oil stocks. I think the reason for this is that whenever we have a panic over higher oil prices, money flows into stocks that offer the chance of reducing our dependence on oil.

The fund's components will likely continue to benefit from this zeitgeist. I think we are probably quite a few years away from mainstream use of solar cells and cars running on sugar, but there will be intense debate and political wrangling about this topic. The hotter the rhetoric, the more capital that might flow into the PowerShares fund or its component stocks.

Alternative in Name, Performance the Same
The PowerShares Clean Energy Portfolio (PBW) has tracked the energy sector at large over the past year, as represented by the Energy Select Sector SPDR (XLE)
Source: BigCharts.com

On the flip side, if oil goes back to $40 and stays there (which I don't think is likely), I expect the fund would get crushed.

It is a small-cap product that favors growth. PowerShares breaks down the style as 86% growth and 14% value. As you might expect, there is no dividend.

On the basis of its option action, the fund is a hot potato. The implied volatility for an at-the-money call option for April is 73%, but an at-the-money call for the Energy Select Sector SPDR (XLE Quote) comes in at only 24%. The short and sweet of these numbers is that the market expects much more action out of the PowerShares fund.

One other quirk worth mentioning is that three of the fund's top 10 holdings have market caps under $400 million. It is possible that a massive inflow of new money into the fund could be the tail that wags the dog with regard to moving the market in some of the components. There could be a big lift on the way up, but also sharp action on the way down.

The idea of owning alternative energy is compelling, but it's not for the faint of heart.

Brokerage Partners